Tuesday, November 13, 2012

Emeco Holdings -- Equipment Leasing





Emeco Holdings buys earth moving equipment and leases it to businesses in the mining sector: iron ore, gold, coal, and copper in Australia, Chile, Canada and Indonesia. The company was founded in 1972 and, after a period when it was owned by a private equity firm, was floated on the ASX in 2005.

The business model should be familiar by now: like Silver Chef, Northbridge, and Northgate, the name of the game is specialization, risk spreading, niche market domination, and balance sheet flexibility.

Like Northgate, it over-depreciates. See here:


Or here, in figures provided by the company itself for the period 2009-2012:


Maintenance capex is therefore about 47% to 48% of depreciation. Knowing this allows us to build an accurate economic picture of the company:


So Emeco is worth AUD $1.43 per share (if we use the average operating profit over the last business cycle), or AUD $2.48 per share (if we use the average return on net operating assets and apply it to Emeco’s current installed capacity). The stock is trading at $0.47 – i.e. at either 1/3rd or 1/5th of its intrinsic value.


It is free cash flow positive and there are no covenant or liquidity issues. Hell, at $0.48, it is trading below liquidation value.

If you can break Emeco, hats off. I can’t.

Disclosure: No position.

6 comments:

  1. Dear Red
    Interesting post. Many of these Oz mining services suffer from being marginal service providers at the volatile end of the cycle and have no control over miners capex who in turn have no control on commodity prices. IE: Emeco's fleet utilisation has dropped to around 60% in Australia and many of its 2013 coal-based contracts are also coming up for expiry which may result in again further and lower utilisation and less pricing power going forward. Yes assets are worth less than the market ascribes, but if they sit idle, are rented for significantly less or are sold close to their WDV because they are not being utilized, Emeco's 'earnings' can be broken for a long-time still. Granted the share price is most likely already discounting this. By the way I couldn't find the link to your email address on your site? I would be interested in getting in touch.
    Regards
    John

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  2. Hi John, thanks for the comment.

    My thinking was (is) that (a) Emeco is trading at almost half the price of its comparables; (b) its global utilization rate is in the 70s; and (c) 2nd half of 2009 saw a bigger drop in utilization and FCF came in at 13c per share because it was able to sell down its inventory.

    The pricing of the renewal of the long term Australian coal contracts is, to me, a test for/of management. If they take the long, strategic view and don't engage in steep price cutting, Emeco will rise to become one of my favorite ideas. As it is, it seems to me a stock priced for the worst case scenario.

    My email address is theredcorner66 at gmail.

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  3. One of the biggest benefits probably, is that renting doesn't involve a lot of cash to be put in since you just need to pay for the equipment when you need it. Because of renting equipment, you even don't need bother regarding servicing so much that's the reason equipment rental is an inexpensive preference.

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  4. red,

    Much obliged as always; I've read back from your more recent post.

    Could you explain the first table a little more for me? I can intuitively see how GFA/Revenue is a very strong hint that they're overdepreciating - particularly if utilisation rates are staying flat - but I can't figure out the logic on the lines beneath that.

    I need to have a longer look at the annual report, but for someone who's never bought a foreign stock - to my detriment - it's very tempting. The investing premise seems extremely simple, particularly since the company can so easily adjust its asset base by allowing depreciating and not investing as much in future equipment.

    Thanks!

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    1. Hi Lewis,

      I'll start at 2009 because they changed their strategy a little in that year, concentrating on higher value equipment for the mining sector and virtually eliminating the lower-value equipment for the civil construction market. You can see that GFA/Revenue jumped up from ~1.42 to ~2.35.

      Okay, so the dollar ratio of the equipment at cost to revenue is $2.53-to-$1. There's some volatility in utilization rates so that relationship wobbles a bit (+/- 0.14) but 2.53:1 is good enough rule of thumb.

      So, since revenue has increased by $364 million, we can estimate that growth capex is more or less 2.35 x 364 = $855 million. (i.e. at the 2.35:1 ratio, it takes an additional $855 million in equipment to generate $$364 million in increeased revenue)

      Whatever remains must therefore be maintenance capex, so
      total capex minus disposals = $1,106
      growth capex = $855
      therefore maintenance capex = 1106 - 855 = $251 million over that four year period.

      Accounting depreciation over that time period sums to $451 million which is almost 2x maintenance capex and is therefore too high.

      Now, the company helpfully breaks out maintenance capex (they call it "sustaining capex") and their figure for the 4 year period 2009-2012 comes to
      Sustaining capex = 428.8
      minus
      disposals = 165.5 = $263.3 million

      which is close enough. A longer time series would see these two values (251, 263) converge.





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